Contract Formation: Let’s Stick Together

Gillian Cordall looks at the basics of contract formation and points up their relevance to the real world IT or e-commerce transaction.

This is the first in the series of Back to Basics articles and to get the ball rolling we are going back to the very beginning, which - in the words of Julie Andrews - is a very good place to start. Dealing with contracts is pretty much unavoidable for IT lawyers so clearly it is vital to know what a contract is and how and when a contract is formed. Given this, it is interesting to discover just how difficult it can be in practice to confirm whether or not a contract has even been made and, if it has, what exactly its terms are. What is the position, for example, where the parties have been involved in protracted negotiations and they decide to commence performance of the contract before the negotiations have finished and the formal contract is concluded? The large number of court cases attest to the fact that the simplest of rules on contract formation can often be very difficult to apply in real life.

So, how can you be sure that a contract has been formed? We are all taught that, in order for a contract to be formed, there has to be offer, acceptance, consideration and an intention to form legal relations. So let's look at each of those elements in turn.

Offer

An offer is a statement made by one party to enter into a contract on specific terms. In order to constitute an offer the statement has to be specific, complete, and capable of acceptance and the offeror must intend to be legally bound on acceptance. An offer can be made to one or more people, even to a general and unidentified group (Carlill v Carbolic Smoke Ball [1893]1 QB 256 - one of those cases that sticks in the mind even decades after law school). An offer must include the terms of the agreement and not leave room for further negotiation.

It is worth remembering that not all statements which appear to be offers are actually offers in the contractual sense. You may need to distinguish between statements which are offers and statements which are invitations to treat (ie a statement which invites another party to make an offer with the intention of being bound). Simple examples of an invitation to treat include a shop window display. The shop-owner is not making an offer by placing priced goods on display – he or she is merely inviting the public to make an offer to purchase the goods at the price specified.

The distinction between an offer and an invitation to treat is important when considering the position of online retailers. For example, is Amazon making an offer to sell goods on its web site or is this merely an invitation to treat? A number of online retailers have over the years mispriced goods on their sites, including Argos who had the misfortune to do this twice, leading to the question of whether or not they are obliged to sell at those incorrect prices. Whilst not tested by the courts, it is generally assumed that an online retail site is analogous to a shop window display and thus displays an invitation to treat, in which case a customer making an offer at the incorrect price can have that offer rejected by the retailer.

The safest course is to ensure that the terms and conditions make it clear that the retailer is not making an offer and to ensure that the mechanism by which consumers place orders for goods from the site is set out carefully. The second Argos example from 2005 is a good example of an online retailer getting this right. In 2005, the Argos web site displayed televisions at a price of £0.49 rather than £349.99. However, Argos was safe in rejecting the orders it received as its terms and conditions specifically addressed pricing errors, the terms and conditions were accepted by customers as part of the ordering process and the confirmation e-mail sent on receipt of the orders did not undermine the terms and conditions, permitting Argos to send a subsequent e-mail declining the orders once the mistake was discovered.

At this point it is also worth noting the requirements of the Electronic Commerce (EC Directive) Regulations 2002 (the E-Commerce Regulations) and also the Consumer Protection (Distance Selling) Regulations 2000 (updated in 2005) (the Distance Selling Regulations). Under both sets of Regulations, certain information, much of which overlaps, must be provided by online retailers. Note that the E-Commerce Regulations apply to sales concluded by electronic means to both businesses and consumers, whilst the Distance Selling Regulations apply only when selling at a distance to consumers. Under the E-Commerce Regulations, the seller is required to provide certain information in a clear, comprehensible and unambiguous manner before an order is placed: such information includes the following - the technical steps required to conclude the contract, whether or not the concluded contract will be filed and whether it will be permanently accessible and the technical means for identifying and correcting input errors prior to placing orders.

A second area where you may come across an invitation to treat is in tendering situations. Care must be taken to ensure that the seller does not inadvertently bind itself to a contract with any bidders by stating in the invitation to tender that, for example, a certain type of bid will be successful (see Harvela Investments Ltd v Royal Trust Co of Canada [1984] 2 All ER 65) as this may amount to a contractual offer.

As we have seen above in the Argos example, even when an offer is made it can be revoked. Offers can fall away through lapse of time when an offer is made for a specific period. An offeror can also withdraw the offer at any time before acceptance. The offeree can also reject an offer for any reason – once an offer is rejected, offerees cannot then change their mind and accept it again. If they try to do that, they may be making a new or counter offer themselves which can be rejected. Finally, offers are revoked in some cases by death of the offeror and also can be revoked on the failure of a condition precedent.

Acceptance

In order for a contract to be formed, the offer must be accepted by the offeree and the acceptance communicated to the offeror. An offer is accepted when the offeree communicates its final and unqualified agreement to the offer on terms which match the terms of the original offer. If the offeree communicates its acceptance with variations to the original offer, this does not constitute acceptance and can be treated as a counter offer. However this is not necessarily a hard and fast rule: In Butler Machine Tool Co Ltd v Ex-Cell-O Corp Ltd [1979] 1 All ER 965 a contract was found to be formed even though the offer and acceptance did not match. You will also recall the so-called 'battle of the forms', where contracts are negotiated using standard terms and conditions. The question arises as to which terms and conditions prevail where a supplier tries to contract on its own terms and the buyer tries to accept whilst imposing its own standard contract. In general, the last set of terms and conditions prior to acceptance or performance should prevail and this has often been the line taken by the courts. However you should note the recent case of GHSP Inc v AB Electronic [2010] EWHC 1828, where the court decided that neither parties' terms and conditions applied and the parties had in fact concluded a contract which incorporated the implied terms from the Sale of Goods Act 1979. In this case, the effect was to negate any limitation of liability in the contract.

In addition there has been a line of recent cases where the Court of Appeal has decided that no contract at all has been formed (eg see Whittle Movers v Hollywood Express [2009] EWCA Civ 1189 and RTS v Muller [2009] EWCA Civ 26). However, with the Supreme Court decision in RTS v Muller [2010] UKSC 14 overturning the Court of Appeal on this point, it may be that this trend has now fallen away. The main point for the practitioner to take away is that it is far preferable for the parties to agree the contracts properly on terms that are clear and as unambiguous as possible rather than to go to the expense and uncertainty of having the courts decide what bargain has been made.

A final point on acceptance is that it must be communicated to the offeror. Unless the communication method is specifically nominated by the offeror (in which case, the offeree must usually use that method), the offeree may accept an offer in any way he or she chooses. There is no reason why offers cannot be accepted by e-mail, on Twitter or by IM. If an offeror does not wish to permit acceptance by such methods, then they would be wise to specify the method of acceptance.

Consideration

The third element of a binding contract is consideration. For an agreement to be enforceable under English law, consideration must be provided to the offeror – ie the person making the promise must receive something in return.

Consideration does not have to be adequate. It does not have to match the value of the promise being made provided that it has some value, which is why contracts are often made for a consideration of £1 and in the past have been made in return for peppercorns, nutmegs and the like. Consideration does not have to be monetary – it can consist of a promise made by the offeree in return. In general, past consideration is no consideration – if the offeree is already obliged to make a payment (such as the payment of an existing debt) then this cannot form the consideration for a new obligation. Finally consideration must move from the promisee – ie the person who is enforcing a contractual promise made under the contract must provide the consideration.

If there is no consideration, in order to be binding, a contract has to be concluded by deed.

Intention to Create Legal Relations

The final piece in the jigsaw is the requirement that there should be an intention to create legal relations. A contract cannot be created unless it was intended that the arrangements should be legally binding.

How can the intent be judged? The existence of all the other factors above will be a clear indication that the parties really did intend to create a contract. However, if I say that I will pay you £20 if you wear a gorilla suit to the office and I refuse to pay up when you do, it is unlikely that this arrangement was intended to be legally binding which is why this rather nebulous fourth requirement is added. The test is an objective one: would a reasonable person believe the agreement is legally binding?

Whilst in social and domestic situations there is a presumption against an intention to create legal relations, in commercial transactions the opposite is the case. Therefore, bear in mind that, unless there is something in the contract which rebuts this presumption, an intention to be legally bound will be implied into any commercial agreement. The more specific you are, the more likely that the presumption will be rebutted. For example, the phrase 'subject to contract' is often used but you do need to be careful as its use is not necessarily conclusive either way. In Investec Bank (UK) Limited v Zulman [2010] EWCA Civ 536 for example, the court refused to uphold the terms of an unsigned guarantee which stated that the parties needed to take independent legal advice before signing the document. The argument made (and rejected) was that earlier drafts of the guarantee were expressly made subject to contract, but the later document was not, which gave rise to an oral contract. The court made it clear that it is the intentions of the parties which are important and that too much emphasis should not be placed on the phrase 'subject to contract'.

Similarly heads of terms and other pre-contractual documentation must be thought through carefully and it must be made clear whether or not they are legally binding. Just including a heading 'Heads of Terms' does not make a document non-binding - these words have no specific legal meaning and other wording or evidence may well point to an intention to create legal relations. 

Some final points

So, if all these points are in place, do you have a contract? Not necessarily. Even if all the above elements are present, if the contract is too vague, it will not be enforceable. However, if a contract is just difficult to implement it will not necessarily be unenforceable for vagueness, and the courts will in any event, depending on the facts, go some way to finding a contract enforceable even when its terms are not entirely clear.

For all that movie mogul Sam Goldwyn claimed a verbal contract 'isn't worth the paper it's written on', there are relatively few cases where writing is actually required ... but it's worth being aware of them. For example, assignments of copyright must be in writing. .Some forms of contract must be concluded by deed (eg powers of attorney). In general, however, contracts can be concluded orally and even written contracts do not have to be signed in order to be enforceable. The courts have found valid contracts to exist where they have not been signed and where all the terms have not been agreed – in particular where the parties have been carrying out their respective obligations in accordance with the unsigned contract.

Points for the Practitioner

With all the above in mind, these are some points to keep to the fore when drafting.

·         Make sure the terms of the contract are clear. If clients use jargon to express themselves, make sure you – and the client – know what they actually mean and incorporate this into the contract in plain English.

·         Make good use of defined terms in your contracts and use them consistently throughout.

·         Ensure the contract includes everything. Do not leave anything out or assume that other documentation may clarify or vary the contract. It may not. Again, it is better if you ensure the terms your client wants are specifically included, rather than allowing them to be implied (but that is a matter for another article).

·         Ensure that the method and timing of conclusion of the contract is completely clear.

·         Use 'subject to contract' throughout your negotiations but remember this is only evidence that you didn't intend to enter into contractual relations at that point, rather than a cast-iron guarantee that you won't be found to have concluded a contract if the rest of the evidence points the other way.

·         Include an up-to-date entire agreement clause – if other documents form part of your contract, incorporate them specifically by reference.

·         If the agreement is not to be concluded by deed, make sure there is some form of consideration in the contract.

·         If drafting heads of terms or other pre-contractual documents, make it clear on the face of the document that it is not legally binding on the parties. If your heads of terms include clauses which are legally binding (such as confidentiality provisions), again make this express in the document.

·         If drafting terms and conditions, make it clear how an offer is made and how and when it is accepted. If something is an invitation to treat, again make this express in the terms.

·         If drafting a variation to an existing contract, ensure there is consideration passing for the variation.

·         And finally, check your boilerplate clauses – eg notices, choice of law and jurisdiction, entire agreement. Make sure they are suitable and up-to-date. See Investec Bank v Zulman and RTS v Muller for the potential consequences of not considering the boiler plate. 

Gillian Cordall is a Trustee of the Society of Computers & Law and a member of its Media Board. She is a Consultant Solicitor at Keystone Law. : Gillian.cordall@keystonelaw.co.uk

 

Published: 2010-10-28T08:25:04

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